Moneyization Part Sixteen
Moneyization: The global financial phenomenon of individuals and businesses moving their funds to monies in which they have the highest confidence, or money in which they have a higher store of faith.
Or, The Chairman Almost Confessed
In the past week, the outgoing, hopefully, Chairman of the Federal Reserve spoke at Jackson Hole, Wyoming for a meeting of the dreaded central bankers. His words were widely quoted and readily available on the Fed's website. That the meeting is held annually in that location has always seemed appropriate. Bandits and other undesirables often traveled through there during the 19th century. The desperadoes of that era, though, had a certain integrity when compared to central bankers. Since they wore masks and carried their guns at the ready, little doubt existed that you were about to be robbed. Central bankers are more subtle.
While the cable news shows can still find some that do not understand the danger in the impending U.S. housing market crash, at least the Chairman is starting to recognize the obvious. He noted, "Nearer term, the housing boom will inevitably simmer down"(Greenspan,2005,¶ 3) Is "simmer down" the NASDAQ plummeting from 5000 to the first bottom? Was that near fatal collapse in the NASDAQ stocks nothing more than a "simmer down?" What will be the value of your home when prices "simmer down?"
Next the Chairman commented, " . . . home price increases will slow and prices could even decrease" (Greenspan,2005,¶ 3) . That's the phrase that bothered everyone. That's the phrase that rattled the psyche of so many. Commenting further he said, "As a consequence, home equity extraction will ease and with it some of the strength in personal consumption expenditures"(Greenspan,2005,¶ 3) . That statement is as close as anyone at the Federal Reserve has come to saying a Great Recession is likely to follow the bust of the housing bubble. However, we note that the good Chairman did not accept any of the blame for the situation.
Many are still deluded into thinking that housing prices are a local phenomenon. That condition was true in 1955. In 2005, as will be explored in the September issue of THE VALUE VIEW GOLD REPORT, housing prices are a national phenomenon. The financing of housing has taken a giant step from the days of our parents borrowing money for their two bedroom, one bath home at the local savings & loan. Hyman Minsky did not write enough, but his musings on financial fragility and instability are about to become a whole lot more well known.
The Chairman went on to comment on the likely "... rise in the personal savings rate, a decline in imports, and the corresponding improvement in the current account"(Greenspan,2005,¶ 4) that will follow the lower level of "home equity extraction." Greenspan said, "Whether those adjustments are wrenching will depend, as I suggested yesterday, on the degree of economic flexibility that we and our trading partners maintain, and I hope enhance, in the years ahead"(2005,¶ 4).
Those last comments are extremely important. For what they mean is that the difference between "simmering down" and a Great Recession in the U.S. lies with the attitudes and expectations of U.S. trading partners. In short, will they continue to hold about one and a half trillion dollars of U.S. debt while watching the U.S. collapse into an economic abyss? As with elections, we have some early indications from the exit polls. The early "exit polls" suggest that the existing incumbent is losing support.
The first graph, an old favorite, is from the weekly data released by the Federal Reserve. Included in that data is the size of holdings of U.S. government debt by foreign official institutions, central banks, at the Federal Reserve. Plotted is the year-to-year change in the size of these holdings. At this time last year, foreign central banks were adding to their holdings of U.S. IOUs at over a $300 billion annual rate. That rate of acquisition tapered off till in early 2005 they were buying at about a $200 billion rate. Their hunger for U.S. debt continued at that rate till the most recent release.
$200 billion had come to be almost a "support level," using the parlance of the trader. As is apparent in the graph, the most recent action broke through that "support level." The year-to-year change has now broken below the $200 billion level. That most recent plot is approximately $188 billion. Any contention that foreign central banks are not losing their appetite for U.S. IOUs would be contrary to the picture in the graph. No they are not yet selling, but their appetite for buying is certainly waning, and the latest data is more than a little ominous.
The second graph is another way of viewing this data, and reflecting on the meanings within it. Plotted with circles is the year-to-year percentage change in the holdings of the U.S. debt at the Federal Reserve by those foreign official institutions. The triangles are the year-to-year percentage change in the holding of U.S. debt by the Federal Reserve itself. Two observations on this picture are important.
First, the willingness of foreign central banks to acquire U.S. debt is clearly falling. Now the rate of increases has fallen below 15% versus over a 30% annual rate a year ago. This line is a momentum measure. As good technicians know, momentum declines before a series turns down. To forecast anything other than a declining sponsorship for U.S. debt requires the identification of some new motivation for foreign central banks to buy U.S. debt. Perhaps all the goodwill the U.S. has built up in recent years?
Second, the gap between those two series explains the source of the error in the inflation forecasts of most of us, including this author. Those trends also explain why the forecasts for higher inflation, aside from that due to the collapse of the U.S. dollar's value, are likely, as in the broken clock's time, on track to be right. To date, the Federal Reserve has not had to monetize government debt in an excessive manner due to the foreign financing. That situation is trending toward a change.
The massive purchases of U.S. debt served to recycle dollars back into the U.S. economy. This action did not create new dollars, which would have pushed up U.S. inflation. These dollars were unfortunately redirected into the U.S. housing market. The purchasing power of those dollars, in terms of how much housing a dollar will buy, has plummeted. That action may not qualify under a pure definition of inflation, but the effect is the same.
As the dollar recycling was so intense, the Federal Reserve's purchases of U.S. debt were not great enough to increase U.S. inflation, especially the government's phony number. Their creation of base money was moderated by the dollar recycling by central banks. The gap between those two series is a measure of monetary pressure on the U.S. inflation rate. That gap is portrayed in the third graph. Being somewhat naive, an assumption is made that the artificial calculations of the U.S. CPI will not continue to overcome reality.
The data plotted in the third graph is the year-to-year percentage change in Federal Reserve holdings of U.S. debt minus the like number for foreign central banks. When negative, foreign central banks are acquiring U.S. debt at a far faster rate than the Federal Reserve. This recycling of, rather than creation of new dollars, does not have a direct impact on the overall general level of inflation. Yes, the focus of those dollars into housing debt has created a price bubble in that market. When the gap is positive, the inflationary potential will be greater as the Federal Reserve will be financing the U.S. government.
As this gap, portrayed by the line of squares in the graph, moves into positive territory, the pressure on U.S. inflation will be in an upward direction. That development, combined with higher oil prices and the collapsing global purchasing power of the U.S. dollar, may make the pricing environment far different than financial markets currently expect. The purchasing power of the U.S. dollars is about to enter a dramatic bear market, and she is going to demonstrate a particularly nasty disposition.
Compounding the seriousness of this outlook is the lack of skills at the Federal Reserve. For about the last five years, the Federal Reserve has only used one tool, easy money. The Fed's response to every event has been to lower rates. Now that policy tool has lost its effectiveness. For example, lower interest rates will not increase oil supplies, pushing prices down. Easy money tool has been used too often, and is now doing nothing more than increasing the downside of the housing bubble.
One aspect not yet touched are the implications of this massive pile of dollars in the hands of foreign holders. Too many dollars exist in the world, and many in possession of those dollars do not particularly want them. Second, they may need to spend them. Oil is priced and traded in dollars. Surplus dollars are being used to bid the price of oil higher in dollars. Those dollars flowing to the oil producing regions are not flowing back and will not flow back into the U.S. How many copies of mortgage processing software does an oil nation need? Anyone receiving oil dollars is going to be buying goods that are produced by the same nations with which the U.S. is experiencing a trade deficit. They are not going to be buying U.S. produced goods as their consumers are not much different. They too would rather have a laptop, an iPod or a cell phone.
What is being created is a vast, swirling pool of dollars in the oil market with nothing to do but buy oil. Consider that graph of the trend in central bank holdings of U.S. debt. Oil prices are simply the mirror image of those holdings. The dollar is becoming useful for only two things, denominating U.S. debt and buying oil. On what else are they likely to be spent? What are the implications for the value of the dollar if its only use is to buy oil? As important as oil is to the world, consumers do not want an unlimited amount of it. What then happens if the dollar is not the only alternative for pricing oil?
The offense in this situation, which is the best defense, is to invest your wealth in assets that will rise in value relative to the dollar. Filling your basement with oil is one choice, though perhaps not an optimal one. Gold is another one, and makes for a far less messy basement. Chairman Greenspan's acknowledgment that housing prices might "simmer down" is a signal of the slow awakening in the world. That awakening is likely to spread, and the dollar will suffer. Owning Gold is perhaps the best option available in a bad situation. Silver, too, is a viable alternative that also should be considered by investors.
Gold, like any market, moves between attractive and unattractive price levels brought on by changes in investor emotions. Having recently broken out of the lateral pattern in which it has been trapped, Gold has confirmed the longer term positive trend. Gold, at the present, is now moving toward another over sold condition and a buy signal. As shown in the last graph, such conditions have been excellent opportunities for dollar-based investors to diversify into Gold. Your next investment choice is between a new, improved version of mortgage software or some Gold. Which is likely to be worth $1,300 first?
Greenspan, A.(2005,August 27). Closing remarks. Jackson Hole, Wyoming symposium on central banking sponsored by Federal Reserve Bank of Kansas City. Retrieved August 28, 2005 from http://www.federalreserve.gov/boarddocs/speeches/2005/200508272.html.